The Madoff Scandal and Charities and Foundations: The Need for All 501(c)(3) Entities to Improve Their Governance and Conflicts of Interest Policies in Advance of Reports for 2008 on Form 990 to be Filed With the IRS – Installment 8

This is the eighth in a series of Installments on this blog that will discuss some issues that face the manifold stakeholders who have been materially affected by the Bernard L. Madoff scandal, allegedly the longest, most widespread and financially devastating Ponzi scheme on record. All potential stakeholders should consult professional advisors promptly to have their positions evaluated.

In this Installment we will complete the current discussion that focuses on charitable organizations and foundations (collectively, “501(c)(3) Entities”) that were affected by the Madoff scandal. Future developments in the Madoff matter respecting 501(c)(3) Entities may lead to additional Installments in this area. Again, we reiterate that the unfortunate experiences of many 501(c)(3) Entities that were directly involved in losses and potential “clawback” from the Madoff morass should be poignant object lessons for all charitable organizations and their fiduciaries and supporters, whether or not victims of Madoff.

Governance Principles Raised in the 2008 Form 990 Filing (the “2008 Filing”)

Installment 7 introduced the new governance disclosures for 501(c)(3) Entities that have been introduced or expanded in the 2008 Filing. Before these changes, matters of corporate governance of 501(c)(3) Entities were generally left to state corporate statutes and case law. The 2008 Filing has broadened the scope of federal scrutiny of the way 501(c)(3) Entities operate. In the 2008 Filing this is done through a series of questions to the 501(c)(3) Entities, together with a request for explanations in certain areas

A number of 501(c)(3) Entities had close ties with Madoff and his associates, including in some cases, their membership on boards. If some of the new inquiries in the 2008 Filing had been in place in earlier years and had been fully and accurately answered, the potentially inappropriate relationship of Madoff and his associates to such 501(c)(3) Entities may have been brought to light. The following questions in the new 2008 Filing fall in this category:

1. Are there any family or business relationships among officers, directors, trustees and key employees of the 501(c)(3) Entity?

2. Is there any “material diversion” of the 501(c)(3) Entity’s assets?

3. Does the 501(c)(3) Entity prepare contemporaneous documentation of all board and committee meetings?

4. Does the 501(c)(3) Entity have a written conflict of interest policy with annual disclosure of related transactions with the 501(c)(3) Entity by officers, directors, trustees and key employees? (New Schedule O to the 2008 Filing asks for information about regular monitoring and enforcement of compliance with this policy.)

5. Was the 2008 Filing provided to the board before it was filed? (New Schedule O to the 2008 Filing asks for the process used by the 501(c)(3) Entity to review the 2008 Filing by the board and its audit committee, if any.)

6. New Schedule O to the 2008 Filing asks how governing documents, conflicts policy, the 2008 Filing and financial statements will be made available to the public.

While the 2008 Filing does not mandate that the 501(c) Entity have all of these and other governance policies in place or the type of policy that is required, the universal availability of the 2008 Filing makes it almost a necessity for a 501(c) Entity to take sufficient preparatory steps to be able to answer all of the questions in the affirmative as a matter of “best practices.” Otherwise potential donors, granting organizations and foundations, and governments may choose not to provide funding to a 501(c) Entity that has less than fully adequate responses.

Moreover, in future years it can be expected that the Form 990 will become even more stringent in its disclosure requirements, perhaps even setting minimum standards for conflicts of interest and other policies.

Conclusions Respecting Governance of 501(c) Entities after Madoff

The unfortunate Madoff scandal, an adverse economy and other events have combined to create challenging times for charities and their stakeholders. A properly prepared Form 990 that reflects recent proactive changes in governance and operations under the leadership of the governing board will go far in repairing the damage to the images of those that invested with Madoff and in enhancing the reputations of those that avoided the Madoff morass.

The next Installment will discuss the impact of the Madoff morass on those that invested with him indirectly through “feeder funds,” other vehicles or even unwittingly.